EFFECT OF INFLATION

1. Reduce Purchasing Power:

The first effect is just another way to define inflation. We know that inflation is
an increase in the overall price level of goods and services in an economy over a
period of time. Therefore, if you want to maintain the same level of your living
standard, you have to pay more. It’s mean that the value of money is decrease,
which lead to the reduction purchasing power of consumers.
A ‘basket’ of goods and services is used to track inflation in a specific market or
country. The ‘basket’ is recurrently adjusted due to changes in consumer bias. It’s
used in calculating Consumer Price Index (CPI) - the most common measure of
price changes.
2. Motivate spending and investing:
Because inflation erodes the real value of money, it is better to hold less money
and buy things that probably won’t lose value. For consumers, that means filling up
gas containers, stuffing the refrigerator, buying shoes or clothes in larger size for
children... For businesses, it means making capital investments because inflation
can affect the liquid assets. Many investors buy gold or investment products with
returns that are equal to or greater than inflation.
3. Causes More Inflation
Unluckily, the desire to spend and invest tends to boost inflation in succession.
As people and businesses spend more rapidly, the economy finds itself overstocked
in cash no one wants. In other words, the supply of money exceeds the demand,
and the price of money – the purchasing power of currency – falls at a rapid rate.
The result is hyperinflation.
4. Raises the Cost of Borrowing
For the past century in the U.S. the approach has been to manage inflation using
monetary policy. To do so, the Federal Reserve (the U.S. central bank) relies on the
relationship between inflation and interest rates. If interest rates are low, companies
and individuals can borrow cheaply to start a business, employ new staffs, or buy a
new office. In other words, low rates urge spending and investing.
By raising interest rates, the regular payments on that boat seem a bit high.
Better to put some money in the bank, where it can earn interest. When there is not
so much cash sloshing around, money becomes scarcer. That scarcity increases its
value, although as a rule, central banks don't want money to become more
valuable, they fear whole deflation nearly as much as they do hyperinflation.
Rather, they drag on interest rates in either direction so as to maintain inflation
close to a target rate.
Another central banks' function in monitoring inflation is through the money
supply. If the amount of money is growing faster than the economy, money will be
worth less and inflation will arise. When central banks want to raise rates, they sell
government securities and eliminate the proceeds from the money supply. As the
money supply decreases, so does the rate of inflation.
5. Reduces Unemployment
There is some evidence that inflation can wear down unemployment. According
to sticky wage theory, wage have a low response to changes in economy. John
Maynard Keynes theorized that the Great Depression led to the sticky – down
wages. Because workers didn’t accept reduction in salary, they were sacked
 instead. Therefore, unemployment dramatically increased. The same phenomenon
may also work in sticky – up wages. It means that when inflation rises into a
certain rate, employers' real payroll decreases and more worker can be hired. That
hypothesis shows the inverse connection between unemployment and inflation.
6. Avoid deflation:
Deflation is the overall decrease in prices for goods and services occurring
when the inflation rate falls below 0%. At this time, the value of money is
increasing. It reduces the spending because people rather buy later than now. It also
results in economic stagnation. Deflation increases the real value of money and the
real value of debt. Debtors have to spend more of their income to pay all of their
debts. So, it is important to maintain inflation in a reasonable level.
Many policymakers believe that a reasonable level of inflation rate is about 2
percent. The inflation rate is low enough to allow the economy to subsidy fully
from price stability. It avoids unproductive activities which prevent economic
growth.